Increasing taxes probably won’t prevent the United States’ debt-to-GDP ratio from rising indefinitely, according to a policy analysis from the Cato Institute.
The COVID-19 pandemic didn’t substantially alter the projected path of the U.S. fiscal imbalance, said Jeffrey Miron, Cato’s director of economic studies, in the December 8 analysis. “That bit of good news does not alter the grim long-term U.S. fiscal outlook. The most effective way to slow the growth of the debt burden is to cut entitlement spending substantially,” he said.
“Even if nominal GDP . . . grew at 4.4 percent indefinitely (which is faster than the [Congressional Budget Office's] baseline assumption of 3.9 percent nominal growth per year), tax revenue increased proportionally, and the dollar value of federal deficits were unchanged from my base-line scenario, the debt-to-GDP ratio would still rise indefinitely, reaching 100 percent in 2049,” Miron said.
Increased relief spending, lower GDP growth, and lower tax revenue will cause deficits to balloon over the next few years, Miron said. “Longer term, however, lower interest rates and slight declines in mandatory outlays will help offset some of these fiscal effects.”
Economists generally agree that drastically increased spending is appropriate to deal with the pandemic, and many agree that eventually raising taxes will be an unavoidable way to tackle mounting debt. Some have explored various ways to tax wealth, while others emphasize promoting growth along with eventual spending cuts.
Overall, Miron said, COVID-19 hasn’t changed the fact that the U.S. fiscal imbalance remains large and unsustainable because pre-pandemic entitlement programs and other expensive policies, such as Medicare, Medicaid, Social Security, and the Affordable Care Act, had already put U.S. fiscal policy on that path.
Miron’s projections show that even substantial increases in federal revenue — stemming from higher taxes — relative to GDP wouldn’t lower the U.S. debt burden meaningfully because higher revenue decreases the level of debt but not its growth rate, he said.
“For example, if long-term revenue exceeds the baseline by 1 percent of GDP (or about 6 percent of annual federal revenue), the debt-to-GDP ratio will reach 100 percent in 2035, only three years later than in my baseline estimate. . . . This assumes no disincentive effects of higher taxes on GDP growth,” Miron said.
Repeated tax hikes that initially decrease the growth of debt-to-GDP would likely reduce growth at some point and therefore fail to raise more revenue, he said.
“Meanwhile, repealing the Trump administration’s 2017 tax cuts in 2021 would raise revenue slightly, but the debt-to-GDP ratio would still hit 100 percent by 2034,” said Miron.
Other policy proposals to slow the debt burden’s growth include those that might boost economic growth, such as reducing distortionary taxes, Miron said.
While those policy changes are plausibly desirable on microeconomic grounds, even moderately higher economic growth wouldn’t prevent the debt burden from growing indefinitely, Miron said.
“If the United States cannot slow the debt buildup materially via higher taxes, lower discretionary spending, or faster economic growth, that leaves slowing the growth of Medicare, Medicaid, and Social Security as the principal option,” he said, adding that those are the programs that have historically grown faster than GDP and that the CBO projects will continue to do so.
Reducing the U.S. debt to a more sustainable level should be a bipartisan priority, Miron said, “but neither party has given the issue sufficient attention in recent years.”